Economic Growth

(continued)

Based on Textbook:
Dornbusch, Fischer and Startz, Chapters 3 & 4
3-1

7,000
6,000
5,000

CAGR 1980-2014
India: 4.4%
China: 8.8%
Brazil:1.1%
Russia:0.6%
(1989-2014)
South Africa:0.3%

4,000
3,000
2,000
1,000
0

1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014

Real GDP per capita (constant 2005 US$)

8,000

India

China

Russia

South Africa

Brazil

Source: World Bank

3-2

CAGR 1980-2014
India: 4.4%
China: 8.8%
Brazil:1.1%
South Africa:0.3%

1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014

Real GDP per capita (constant 2005 US$)

in 1980 = 100

1,900
1,800
1,700
1,600
1,500
1,400
1,300
1,200
1,100
1,000
900
800
700
600
500
400
300
200
100
0

India

China

Brazil

South Africa

Source: World Bank

3-3

Real GDP per capita (constant 2005 US$)

in 1990=100

900
800
700
600

500
400
300
200
100
0

India

China

Russia

South Africa

Brazil

Source: World Bank

3-4

Growth Theory: The Neoclassical Model

Neoclassical growth theory focuses on K accumulation and its
link to savings decisions (Robert Solow)
Begin with a simplifying assumption: no technological progress
economy reaches a long run level of output and capital =
steady state equilibrium

The steady state equilibrium for the economy is the combination of per
capita GDP and per capita capital where the economy will remain at rest,
or where per capita economic variables are no longer changing OR

y 0, k 0

Present growth theory in three broad steps:

1.
2.

3.

Examine the economic variables that determine the economys steady state
Study the transition from the economys current position to the steady state
Add technological progress to the model
3-5

Determinants of the Economys Steady State

The production function in per

capita form is y = f(k) and is
depicted in figure.

As capital increases, output

increases, but at a decreasing rate
diminishing MPK

An economy is in a steady
state when per capita income
and capital are constant

Arrive at steady state when

investment required to provide
new capital for new workers and
to replace worn out machines =
savings generated by the economy
3-6

Savings and Investment

The investment required to maintain a given level of k

depends on the population growth rate and the
depreciation rate (n and d respectively)
Assume population grows at a constant rate, n

N
, so the
N

economy needs nk of investment for new workers

Assume depreciation is a constant, d, of the capital stock, adding
dk of needed investment
The total required investment to maintain a constant level of k is
(n+d)k

If savings is a constant function of income, s, then per

capital savings is sy

If income equals production, then sy = sf(k)

3-7

Solution for the Steady State

k is the excess of saving over

required I: k sy (n d )k
k = 0 in the steady state and
occurs at values of y* and k*,
satisfying sy* sf (k*) (n d )k *
Savings and required
investment are equal at point C
with a steady state level of
capital k*, and steady state
level of income y* at point D

3-8

The Growth Process

The critical elements in the

transition from the initial k to
k* are the rate of savings and
investment compared to the
rate of population and
depreciation growth
Suppose start at k0: sy (n d )k
Savings exceeds the
investment required to
maintain a constant level of k
k increases until reach k* where
savings equals required
investment

3-9

The Growth Process

Conclusions:
Countries with equal savings
rates, rates of population growth,
and technology should converge
to equal incomes, although the
convergence process may be
slow
2. At the steady state, k and y are
constant, so aggregate income
grows at the same rate as the rate
of population growth, n
Steady state growth rate is not
affected by s
1.

3-10

An Increase in the Savings Rate

According to neoclassical
growth theory, savings does
not affect the growth rate in the
long run WHY?
Suppose savings rate increases
from s to s:
When s increases, sy (n d )k at
k*, thus k increases to k** (and y
to y**) at point C
At point C, the economy returns
to a steady state with a growth
rate of n
Increase in s will increase levels
of y* and k*, but not the growth
rate of y

3-11

The Transition Process: s to s

In the transition process, the higher savings

rate increases the growth rate of output and the
growth rate of per capita output

Follows from fact that k increases from k* to k**

only way to achieve an increase in k is for k to grow
faster than the labor force and depreciation

3-12

The Transition Process: s to s

First figure shows the transition from

y* to y** between t0 and t1

After the savings rate increases, so

does savings and investment,
resulting in an increase in k and y
Y continues to increase at a
decreasing rate until reach new steady
state at y**

Second figure illustrates the growth

rate of Y between t0 and t1

The increase in s increases the growth

rate of Y due to the faster growth in
Y
capital, Y n
As capital accumulates, the growth
rate returns to n

3-13